05/10/2018

Argentina: Monthly Report SBS

Between a rock and a hard place 05/10/2018

Argentina: Monthly Report SBS

 

Between a rock and a hard place

 

 

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Another stabilization attempt. Under a more challenging backdrop for emerging markets, investors punished Argentina for its high external vulnerability. This triggered a confidence crisis that led to a sharp peso depreciation and weakened debt sustainability, forcing authorities to frontload their fiscal consolidation effort and seek further IMF assistance. Categorically reinforcing the international support for Argentina, the revised agreement with the Fund will provide extra time so that the government can launch a new economic program to correct macro imbalances in the least traumatic way possible. Despite significant external support, Cambiemos will face a major challenge ahead of the elections, having to accelerate the fiscal adjustment with damaged approval ratings and just as the economy is entering another recession. Across the sidewalk, the opposition remains weak and unable to present a viable alternative to the government, this being our main source of hope to expect a re-election of President Mauricio Macri. Still, the political scenario for the government seems more challenging than ever.  

Growth under the siege of macro adjustments. Latest activity data showed the recession is becoming deeper, with the outlook for the following months anticipating an ever harder blow. In a lethal combo, wages would be defenseless against a notable inflationary acceleration, a restrictive fiscal policy should turn even tougher and investment would suffer a double punch from financial instability and political uncertainty. The combined effect of all this factors should overweight the cushion of increased exports, creating the conditions for GDP to fall both this year and the next. Still, we expect the economy to begin a rebound with the soy harvest in 2Q19, possibly growing at a 3.0% q/q (s.a.) annualized pace ahead of the election.

A fresh start for monetary policy. The sizable peso depreciation and increased financial volatility fueled high inflation in August and a significant acceleration in September. This completely changed the outlook for the BCRA, that under new management decided to abandon inflation targets and will now seek to decelerate monetary aggregates growth by keeping the monetary base constant. The lags under which monetary policy operates leave little hope that the outlook can improve during the rest of this year, though conditions indicate that we could see a strong disinflation in 2019.

Fiscal consolidation accelerates, with huge international support. Fiscal restraint continues to be the best economic result that the government can show since 2017, with improving prospects. In August, the primary deficit fell 68.75% y/y in real terms and reached 2.5% of GDP in the trailing 12 months, meaning that this year’s fiscal target is almost accomplished. Nevertheless, this was not enough to ease investor concerns and now the government will target zero primary deficit in 2019 on the back of higher export taxes. Almost eliminating external financing needs, IMF funds will provide extra time to correct imbalances, thus allowing net public debt to converge below 40% of GDP by the time the fiscal consolidation is over in 3 years.

And the suggested trades are... Financial stress cornered the government into having to accelerate the correction of the main macroeconomic imbalances, leaving Argentina at a turning point. Even as we are much closer to finally setting the bases for long-term sustainable growth, authorities are also imposing a very hard stabilization program that risks derailing the political strategy despite the opposition remains weak. In this context, we still expect a change in current trends and remain constructive, though waiting for reinforced confidence in the government before adding risk. Among sovereign hard currency bonds, we suggest positioning in the short end and the belly of the curve, anticipating that it could recover some of its slope in a scenario where liquidity concerns have significantly declined. In the local currency space, we like the short end of the CER curve (AF19 and A2M2) as a way of capturing very high inflation in coming months, while we also see value in Badlar floaters (AM20 among sovereigns and BDC24 for provincials) after the BCRA launched a hard monetary program. In relation to equities, we suggest positioning in companies in the export sector as well as those with dollar denominated revenues and low net debt. ALUA and TXAR stand out in this regard, CEPU and TGS are still strong bets in the energy sector and we believe it is time to increase exposure to BYMA and lower positioning in the top 4 banks.

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